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Figure 1. The OECD’s FDI Regulatory Restrictiveness Index for China, 1997-2019
Table 1. OECD’s FDI Regulatory Restrictiveness Index for China and selected countries, 2019
![Does CAI improve rules and the level playing field for EU firms in China? Being able to access the Chinese market in the framework of an international treaty is obviously important for EU investors, but often they face additional problems in China that the CAI tries to remedy. We focus on four important issues: forced technology transfer, state-owned enterprises, subsidies and standard setting. CAI bans forced technology transfers in covered sectors European and other foreign companies established or seeking to establish in China have long complained that China uses foreign ownership restrictions, including joint-venture requirements, to force them to transfer technology (TT) to Chinese entities. China’s WTO commitments have been of limited help in tackling this. In goods sectors, WTO rules apply to trade but not FDI. Hence, in these sectors, China is free to apply ownership restrictions to foreign companies that may lead to unfavourable TT arrangements for foreign investors. In services sectors, WTO rules apply to FDI, but only to the extent that WTO members have assumed specific obligations under GATS Mode 3. As discussed above, China has assumed some Mode 3 obligations in the schedule of concessions for services attached to its Protocol of Accession to the WTO, but some major sectors are excluded, and in some covered sectors, the establishment of foreign firms is conditional on entering into a joint-venture arrangement with a Chinese entity, which may lead to forced TT. Given the limited ability of current WTO rules and commitments to deal with the problem of forced TT in China, some of its trade and investment partners, primarily the United States, China’s Asian neighbours and the European Union, have sought bilateral or regional solutions. It is important to note that in the 2019 FIL, China responded to these concerns by outlawing forced TT. As in the case of many market-access provisions, however, this falls short of a commitment enforceable under an international treaty. The CAI agreement comes on the heels of efforts to impose disciplines on forced TT on China under the Trans-Pacific Partnership/Comprehensive and Progressive Agreement for Trans-Pacific Partnership (of which China is not a member but which had China in mind), and the China-US Phase One agreement. CAI contains the strongest language yet in that regard. Specifically, CAI contains an obligation for the parties not to “impose or enforce any requirement or enforce any commitment or undertaking … to transfer technology, a production process, or other proprietary knowledge to a natural person or an enterprise in its territory.” As noted by Mavroidis and Sapir (2021), the words ‘impose’ or ‘enforce’ are crucial. They imply that states (the parties to the agreement) cannot impose TT requirements on foreign firms that want to invest in their jurisdictions and that, in case such firms decide to do business in their jurisdictions through a joint venture, the local partner will not be able to enforce any commitment for TT that it may have extracted from the foreign partner as a condition for the joint venture. In principle, therefore, even when joint-venture requirements continue to apply, Chinese companies will no longer be able to force unwanted technology transfer on their EU partners. If enforced properly, this measure, which applies to permitted investment in both goods and services sectors, would be a major advance for EU firms investing in China. CAI makes headway in dealing with the problem of unfair competition from (SOEs) For the first time in an international agreement to which China is a party, CAI contains a precise and comprehensive definition of SOEs, by applying rules to SOEs at all levels of government, including local government, and by improving transparency. State-owned enterprises are omnipresent in the global economy and the WTO agreement places no restriction on their operation, provided they operate on a commercial basis. However, well before China’s WTO accession, and increasingly since, concerns about the competitive distortions caused by China’s large and opaque SOE sector have been prevalent. At the time of China’s WTO accession, SOEs accounted for a large share of economic activity in China They still account for between 23 percent and 28 percent of GDP in China today (Zhang, 2019), compared to about 15 percent in the EU. Surprisingly, given these concerns, China’s accession protocol to the WTO (henceforth ‘the protocol’) includes only a few paragraphs that relate to SOEs. The main thrust of China’s commitments were: a) SOEs would buy and sell only based on commercial considerations and the government would not directly or indirectly influence SOEs’ commercial decisions; b) any subsidy to a SOE would be considered specific, hence actionable; c) SOEs would be responsible for their own profits and losses; d) China will notify any subsidy given to an SOE. A notable omission from the protocol was a definition of an SOE, which proved a cause of confusion and major disputes. The CAI refers to SOEs as ‘Covered Entities’, and establishes criteria to recognise them. These criteria go beyond full or majority ownership to include the power of the state to appoint directors and to control the decisions of the enterprise through “any other ownership interest” or even without “any ownership stakes.” Firms granted monopolies by the state are also defined as SOEs. The definition applies at “all levels of government”, which includes the operation of SOEs owned by local and regional government. Under Section 2 Article 3 of the CAI, covered entities must “act in accordance with commercial considerations in the purchases and sales of goods or services in the territory of the Party …” and not discriminate. The CAI does not include specific provisions on notification of subsidies to SOEs (or by SOEs). Instead, subsidies to SOEs are covered under the new notification requirement (services) and under ‘Consultations’ in the Article on Transparency of Subsidies (for goods and services), which apply to all enterprises. However, the CAI establishes a procedure through which a party can demand information about a subsidy, or on an entity that is believed to be subsidising, where it believes its interests are being adversely affected. The information that the requested party must provide is detailed in CAI Section 2 Article 4, and it includes information on ownership, the entity’s revenue, the size of the subsidy and its purpose. Compared to recent trade agreements involving China, the CAI section on covered entities is an improvement. Neither the China-US Phase 1 Agreement nor RCEP includes disciplines on SOEs. China was not a party to the negotiations of the US-led and subsequently abandoned Trans-Pacific Partnership (TPP). However, Chapter 17 of that agreement covers SOEs and was designed partly with China in mind. It is sometimes referred to as the gold standard on SOE disciplines. Thus, it is no mean achievement that the scope of SOE commitments under the CAI is similar and compares quite favourably with those of the TPP’s successor agreement, the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). In fact, whereas the TPP’s provisions apply only to central government, the CAI’s apply to all levels of government, a significant improvement given the importance of China’s province- and local government-owned enterprises. Moreover, the CAI definition of SOEs is more encompassing than that of the TPP, including SOEs for which the government can control decision-making. However, the TPP demands more transparency than the CAI, since it obligates the parties to provide a list of all SOEs within two years of ratification of the agreement. CAI provides new disciplines on subsidies in the covered service sectors The CAI’s disciplines on subsidies in services represent a major improvement since the WTO only covers subsidies in goods trade. Overseas investors in China have long complained of a lack of transparency and unfair competition from subsidised Chinese entities. Subsidy disciplines under the Agreement on Subsidies and Countervailing Measures (SCM) and China’s accession protocol date back to when China was a relative minnow in global trade. As China rose to be the world’s largest trading nation, dissatisfaction with aspects of these agreements grew. The dissatisfaction is heightened by the increasing importance of services in global economic activity and trade, since WTO disciplines do not cover subsidies in services, only goods. The intention to negotiate disciplines on subsidies in services was included in Article XV of GATS, but these negotiations never took off. The most important innovation of CAI is to cover subsidies in the eligible services sectors covered by the CAI. However, the CAI’s enforceable provisions relate only to transparency (notification) and consultation relating to subsidies. If a subsidy above a certain size is found to exist, the subsidising party is not required to remove the subsidy or to accept the complainant’s countervailing measures, only to use its best endeavours to find a solution. The relevant paragraphs in section 3 (Regulatory Framework), Article 8 (Transparency of Subsidies) read: Paragraph 7. If the requesting Party, after the consultations have been held, considers that the subsidy concerned has or could have a significant negative effect on the requesting Party’s investment interests under this Agreement, the requested Party shall use its best endeavours to find a solution with the requesting Party. Any solution must be considered feasible and acceptable by both Parties. And, Paragraph 10. Paragraph 7 shall not be subject to Section X (State to State Dispute Settlement). Neither the China-US Phase 1 nor RCEP include new provisions on subsidies, so the CAI is a step forward. It is also instructive to compare the CAI to the WTO subsidy reforms proposed in January 2020 by the EU as a member of the Trilateral Group, which includes Japan and the United States. The Trilateral Group does not mention China specifically, but the group’s proposals have China very much in mind12. The Trilateral Group proposals relate only to industrial subsidies, not services, but most of the proposals could be directly applied in services as well. In addition to calling for a clear definition of SOEs, which the CAI provides, the Trilateral Group proposed a set of far-reaching subsidy reforms, none of which are envisaged in the CAI, at least explicitly. For example, the Trilateral Group proposals would extend the list of prohibited subsidies to cover state guarantees. The Trilateral Group also proposed that subsidies that are not notified are deemed illegal if they are counter-notified and no written explanation is forthcoming. The implicit reference to China is clearest in the Trilateral Group’s proposal to change the way subsidies are calculated, namely, to replace the use of domestic prices with appropriate benchmarks when the market of the subsidising member is distorted. In conclusion, while the CAI includes important steps forward in subsidy disciplines, deeper reforms, such as those envisaged by the EU and its partners in the Trilateral Group, remain a work-in-progress. CAI helps EU firms participate in Chinese standard setting in covered sectors Technical regulations and standards are important features of modern economic life, which can constitute barriers to international trade and investment. An important condition for foreign firms to have effective access to domestic markets is therefore participation in standard-setting bodies. In the European Union, as elsewhere in the OECD, foreign companies have the same right to participate in standard-setting bodies as EU firms. The situation is different in China. According to a report submitted in 2018 by the US authorities to the WTO13, US companies and other foreign companies operating in China face two types of problems with respect to standard setting. First, Chinese government officials in some cases reportedly have pressured foreign companies that want to participate in the standard-setting process to license their technology or intellectual property on unfavourable terms. Second, China has continued to pursue unique national standards in several high-technology areas where international standards already exist, such as in telecommunications, wireless networks and information security. So far, dealing with this problem has proved difficult. China’s protocol of accession to the WTO contains no obligation on China regarding its standard-setting process. Nor does the US-China Phase One trade agreement. Only the RCEP agreement mentions standard setting, but simply to encourage the exchange of information between the relevant national bodies. The CAI is clearly innovative here. It commits the two parties to allow foreign enterprises that are covered by the agreement “to participate in the development of standards by [their] central government bodies, including related standardisation working groups and technical committees at all levels, on terms no less favourable than those it accords to its own enterprises, including its covered entities.” This commitment is much more valuable to EU firms operating in China than to Chinese firms operating in the EU, since the former currently face much more difficulty than the latter in participating in standard-setting bodies. But it is also a guarantee for Chinese firms that they will continue to be treated like EU firms by government bodies in the EU. It should be noted, however, that the obligation to treat foreign firms no less favourably than domestic enterprises only applies to government standard-setting bodies. In the case of local and non-governmental bodies, the parties have only an obligation to recommend that they provide such treatment. Enforcement Obviously, commitments are only worthwhile if they can be enforced. The CAI’s market-access and level playing field commitments are enforceable via a state-to-state dispute resolution mechanism, as in the EU’s trade agreements with other nations. In case of a dispute, and if the parties fail to reach an agreement through consultations, the complaining party may request the establishment of an arbitration panel. If the panel rules in favour of the complainant and the respondent fails to abide by the decision of the panel and remove the disputed measure within a reasonable period of time, the complaining party may retaliate by adopting an equivalent measure. No international treaty is fool proof, of course, and all treaties depend on the willingness and ability of contracting parties – sovereign nations – to abide by their terms. China’s record on compliance with its trade treaty obligations, notably in the WTO, is no better or worse than that of other nations. It is worth noting, however, that China has been the subject of many WTO disputes and it has a strong record of compliance with decisions of panels and the Appellate Body when they ruled against it.](images/u154895-181.png?crc=3793809121)
![The impact of CAI on the global trading and investment system China is now the world’s largest trading nation in goods, and among the fastest growing. The main systemic implication of the CAI is that it strengthens disciplines on China’s idiosyncratic economic system in important areas. As the European Commission has claimed, the CAI is sui generis, an entirely new type of bilateral investment agreement which covers market access in both the goods and services sectors. Previous bilateral investment agreements – of which there are currently over 2000 in force – cover only investor protection (for example, against expropriation and prohibitions on profit repatriations), not market access. As mentioned, market access through foreign investment in the goods sector is not covered under the WTO, and nor is it covered in China’s accession protocol. In contrast, market access through foreign investment in the services sector is governed under GATS Mode 3 (foreign establishment), negotiated in the Uruguay Round. As discussed in the previous section, China made modest services commitments under Mode 3 in its Protocol, which the CAI deepens and extends. Thus, a notable systemic implication of the CAI is that it may pave the way for new types of bilateral agreements that make international investment in goods and services more open and predictable. This may include progress in the stalled investment negotiations between the US and China. The CAI covers many, but not all, services sectors, and excludes treatment of trade under Modes 1 (cross-border), 2 (consumption abroad) and 4 (presence of natural persons). Therefore, it does not conform to the conditions allowing for an exception to the non-discrimination principle, envisaged for regional trade agreements under GATS Article VI (parallel to GATT Article XXIV). It follows that China’s and the EU’s commitments in services must be extended to all WTO members, under the MFN provision (GATS Article II). Thus, another notable systemic implication of the CAI is that it not only binds and enhances liberalisation of foreign establishment in two of the world’s largest economies, but this is to the benefit of all WTO members, not just the EU. However, since investment in goods is not covered by the WTO, CAI provisions on market access in the goods sector are not MFN, and only benefit the EU. From a WTO perspective, the CAI has some negative and some positive features. The negative feature is that the CAI, because of its bilateral rather than multilateral nature, favours EU over other foreign investors in China, since some of its provisions only apply to EU firms. The most important positive feature is that it advances disciplines in transparency, subsidies, technology transfer and SOEs among two of the world’s largest economies, disciplines which could potentially be incorporated at some stage in the WTO, based on plurilateral or multilateral negotiations involving other WTO members besides the EU and China. Also potentially important for the WTO are the CAI’s sustainable investment provisions, which cover labour and environmental standards. Such provisions are commonly included in the EU’s and the US’s bilateral or regional agreements. However, this is the first time that they have been adopted by China, which has been among the leaders of the developing country resistance against including these disciplines in WTO agreements. Other systemic implications of CAI can be seen from the perspectives of the world’s three largest economies: China, the United States, and the EU. China By adopting the CAI, China has shown that it is willing to consolidate (bind) its progress on investment liberalisation under its FILs into an international treaty, and that it intends to continue to confront Chinese firms with world-class competition on their own turf. In the covered services sectors, the liberalisation is far from complete but affects all foreign investors, not just those from the EU. In goods sectors, the liberalisation has been far-reaching but is internationally bound only as it concerns European firms. However, since these include many of the world’s largest multinationals, the competitive effects on Chinese goods markets could be far-reaching. Moreover, by agreeing to disciplines on transparency about subsidies, SOEs and forced technology transfer, China has taken another step towards promoting ‘competitive neutrality’ between firms that are state-owned (or state-influenced) and private firms, including both Chinese and foreign firms14. Considering the commitments that China made on technology transfer and intellectual property protection in its Phase One deal with the United States, with the CAI China is also signalling, both at home and abroad, that it wants to deal with the major concerns raised by foreign firms competing in China or with Chinese firms on overseas markets. Although China gains little in new market access in the EU (in the market for renewable energy equipment, for example) it scores other important wins. At a time of great trade tensions, the EU binds its commitment to receive Chinese foreign investment with very few limitations. This would not, however, prevent the EU from restricting market access to a Chinese company in case an arbitration panel found that it received state subsidies or acted not in accordance with commercial considerations. In combination with the conclusion of the RCEP negotiations with Asia-Pacific partners, China is showing through the CAI that it is becoming more integrated in global markets and will not be isolated even in the face of potential continued US hostility. China’s unilateral liberalisation and level playing field reforms, consolidated in the CAI, send an important signal to foreign investors that they are welcome, and that China sees their contribution as important for its continued development. The United States There is an assumption15 that the CAI pre-empts EU cooperation with the Biden administration in striking a tougher bargain with China. But it is far from certain, considering thorny China-US relations, that such a bargain was there to be had. As it happens, by agreeing to a temporary suspension of tariffs under the Airbus-Boeing dispute, and in various other ways, the Biden administration has already signalled that it is keen on intensifying its collaboration with the EU on trade matters. More importantly, the CAI clearly furthers US economic interests. The US benefits directly from China’s services liberalisation under the CAI, including the elimination of joint-venture requirements in many sectors. Even though the CAI’s many provisions on transparency, including in subsidies, the definition of what constitutes an SOE, and the strong ban on forced technology transfer apply only to the sectors covered and only to the EU, they directly or indirectly address some of the United States’ most important demands on China. The Biden administration intends to hold China to its Phase One commitments, and – when and if it decides to embark on Phase 2 negotiations – will have the opportunity to coordinate with the EU its position on the outstanding level playing field issues. The EU The EU’s new commitments under the CAI are limited, since its market is largely open and disciplines on subsidies, for example, are already strict. Moreover, as the European Commission has stressed, the EU retains its instruments to screen inward investment from China and elsewhere for any violation of its competitive neutrality criteria. The CAI does, however, demonstrate the EU’s capacity to negotiate successfully and independently with China. In concluding the CAI negotiations, the EU has signalled clearly that it has no intention to decouple from China, a course that some radical factions in the United States and elsewhere advocate. The CAI is both innovative and supportive of the world trading system, in a manner that the highly discriminatory ‘managed trade’ Phase One deal was clearly not. This result was achieved even though the EU had little to give that is new to China beyond binding its investment liberalisation. Since the entry into force of the Lisbon Treaty in December 2009, EU trade and investment policy must ‘be guided’ by fundamental EU principles, including human rights, labour rights and environmental protection. The CAI’s sustainable investment clauses are an important victory for the EU and a major concession by China since – as mentioned – none of the trade agreements it has signed so far, including the RCEP, contains a sustainability clause. The SI chapter legally obliges the parties to the CAI to “effectively implement the ILO Conventions it has ratified and …[to] make continued and sustained efforts on its own initiative to pursue ratification of the fundamental ILO Conventions No 29 and 105 [on forced labour], if it has not yet ratified them.” In case of disagreement between the parties regarding the fulfilment of their sustainable-investment obligations (which cover not only labour, but also corporate social responsibility, the environment and climate change) the matter will be referred to an independent expert panel. The sanction for not respecting sustainable-investment obligations is not retaliation like with market access commitments, but naming and shaming through the publication of the expert panel’s report. This may help China enforce its sustainable-investment obligations, to the extent that it cares about its international image and standing.](images/u154898-120.png?crc=294400469)
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